Edited by Thorsten Beck - Vox

Ring-fencing is good, but no
panacea
Viral V. Acharya
Stern School of Business, NYU and CEPR
The Vickers Commission recommends separating commercial and non-commercial
banking activities in order to protect core financial functions from riskier activities.
This chapter warns that such ring-fencing may fail because there are still incentive
problems in traditional banking activities. The accompanying risk-weighted capital
requirement recommendations will address this only if we do a better job of measuring
risks.
The recent report issued by the UK’s Independent Commission on Banking, chaired by
Sir John Vickers, provided recommendations on capital requirements and contained a
proposal to ring fence banks – in particular, their retail versus investment activities. I
view ring-fencing as potentially useful but argue that the more important question is
whether the risk weights in current Basel capital requirements are appropriate.
The backdrop of the Vickers Commission report is that countries such as the UK,
Sweden, and some others, where the financial sectors are rather large compared to
the size of the countries, are getting increasingly concerned about facing the kind
of banking crises that we faced in 2008. The risks of a double-dip recession and a
slowdown in global growth have increased given the tentative recovery in the US and
the sovereign debt problems in Europe. Hence, some countries are trying for something
more substantial in financial sector reforms than what the Basel III reforms are offering.
Sweden has gone for relatively high levels of capital requirements. The UK is unique
in considering the ring-fencing solution, which involves trying to separate the riskier
parts of banking activities (mainly investment banking and proprietary trading) from
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